Succession Planning

Understanding the tax implications of buying or selling a practice – The asset sale

The second in a five-part series about the decision process when buying or selling a business

For private party transactions, the most commonly utilized transaction structure is the asset sale, regardless of whether the transaction is between current employees, family members or external parties.

As the name implies, an asset sale is a transaction in which the parties agree to buy or sell the business assets that make up a business. There are many reasons why participants choose to structure a transaction as an asset sale, but typically the two driving factors are (1) the assumed legal liability for the buyer, and (2) the ability of the buyer to amortize the purchase price of the business over a finite period of time.

Typically in an asset sale, the buyer and seller contractually agree to the specific assets that will be purchased and to what (if any) liabilities will be assumed by the buyer. The contract will detail exactly what business assets will be sold. Tangible assets may include business equipment, furniture, fixtures and inventory. The contract will also detail other intangible assets – which may include goodwill, trade names, telephone numbers, website address/URLs, etc. For each line item asset, the contract should specify how the purchase price is allocated. The allocation of the purchase price can have a significant impact on both the buyer and seller, as the different asset classes result in different tax consequences for each party involved in the transaction.

It is imperative that the contractual agreement provides the specific allocation of the purchase price to specific assets. That’s because this allocation will determine the ultimate tax consequences for the buyer and the seller. It is a key negotiation point that cannot be overlooked.

Note that both the buyer and the seller are required to file Form 8594, Asset Acquisition Statement. The IRS expects the asset allocations provided in the forms filed by both the buyer and the seller to match. You can imagine the consequences if these forms were filed and did not match.

From a practical standpoint, the seller will generally desire to have an allocation that results in a long-term capital gain. Conversely, the buyer would prefer to have an allocation that results in an immediate deduction. Then there is the IRS and the specific rules relating to the amount allocated to the assets purchased. This is why it’s important to tap experienced counsel, as these divergent interests can cause unintended tax consequences or cause a deal to break down completely. It is important for each party to understand the implications for the other.

For example, allocating the purchase price of business equipment, furniture and/or fixtures would likely result in the recognition of capital gains and potentially ordinary income by the seller. If the sale results

in capital gains, the seller will have to pay the short-term and/or long-term capital gain tax based on how long the assets were owned and whether or not the seller had depreciated them in earlier tax returns. For the buyer, the assets would be eligible for a depreciation deduction over a 3-, 5-, 7-, 10-, 15-, 20-, 25-, or 39-year time period, depending on the types of business assets acquired.

For the purchase price that is allocated to goodwill, the seller is eligible for long-term or short-term capital gains tax treatment, while the buyer would capitalize and amortize the amount paid over 15 years (180 months).

In a transaction where the purchase price is paid in full at closing, the tax accounting is fairly straightforward. However, this is extremely uncommon in the purchase of any business. Most of the time an asset sale/purchase agreement is structured over a long duration, oftentimes with an amount paid at closing and the remainder paid over a period of years.

When the transaction is structured to take place over a period of years and the purchase price is not fixed and determined at closing, the IRS requires the installment sale methodology for reporting and requires the filing of Form 6252 each year until the transaction is fully closed. You can omit this filing if you make a specific and timely election to opt out of the installment method.

This information likely does not address the implications of each specific transaction. Please be aware that this information is intended to provide an overview only and is not a substitute for specific transaction guidance from an attorney, certified public accountant, enrolled agent or other subject matter expert. For specific transactional related advice, please consult with your own tax and/or legal counsel.

CIRCULAR 230 NOTICE: To comply with U.S. Treasury Department and IRS regulations, we are required to advise you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this transmittal is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding penalties under the U.S. Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this document or other related materials.